Germany Is the First Risk for the Euro

By Nicholas Hastings

No, it is Germany that could be the real problem for the euro this week.

One of the key factors supporting the single currency throughout 2011 was investor interest in Germany.

Despite all the problems swirling around other euro zone countries, faith in Germany remained paramount and the euro remained relatively firm.

But, an auction of €5 billion new benchmark 2022 German bonds on Wednesday may well show that investors are starting to lose their faith in the country.

There were already signs of this back in November when a similar auction of German paper was under-subscribed, providing the first indications that even the euro zone’s most powerful member was finally being tainted by the problems of the peripherals.

The euro may well have started off 2012 in good spirits, helped by strong purchasing managers’ reports from China and India as well as upward revisions to ones from France and Germany.

The fact that speculators had pushed their euro shorts to record positions in the last week of 2011 is only helping to create conditions for a bit of a short squeeze.

But, reality will soon bite the euro again.

Spain has already kicked off the new year with an admission that its budget deficit was a full two percentage points higher than anticipated last year, up at 8% of GDP rather than 6%. That is not a good starting point for resolving its debt issues this year.

That will certainly make those successful Spanish auctions at the end of last year look even more like what they really were — a bit of end year exuberance!

Now, Germany is said to be pushing for a 75% haircut on Greek debt. That’s not a hair cut, that is a buzz cut!

On the one hand that might make life a little easier for Greece only having to pay back 25 cents in the euro but it does mean that the country is much more likely to fall into technical default as few lenders are likely to take that buzz cut lying down!

This also means greater costs for the German taxpayer, who in the final analysis, will be footing the bill for saving the euro.

Data Tuesday may have shown that the German unemployment rate has fallen to its lowest since 1991. But, once the very mild winter conditions are factored in and once the ever encroaching impact of the slowdown elsewhere in the euro zone takes its toll, Germany may not look so much a safe haven.

How all this will affect investor appetite for German as well as other euro-zone paper this year remains to be seen.

The omens don’t look good.

France, the next largest euro-member to Germany is still threatened with a credit rating downgrade and issuance calendar for the next three months is choc-a-bloc.

Even with peripheral demand aside, France, Italy and Germany alone will be coming to the market asking for €53 billion.

But, perhaps it is the performance of euro-zone bond yields that say it all.

Despite all the improved risk sentiment in other global markets at the start of the new year, yields remain as high as ever, suggesting that investors remain as wary as ever and that demand for German paper could continue to decline.